|
What is a debt service coverage ratio (DSCR)
The DSCR or debt
service coverage ratio is the relationship of a property's annual
net operating income (NOI) to its annual mortgage debt service
(principal and interest payments). For example, if a property has
$125,000 in NOI and $100,000 in annual mortgage debt service, the
DSCR is 1.25.
Commercial lenders use the DSCR to analyze how
large of a
commercial loan
can be supported by
the cash flow
generated from the
property, or to
determine how much income coverage there is at a certain loan
amount.
Two of the most important factors used to determine the
approvability of a commercial mortgage request are the DSCR and
loan-to-value (LTV). Often times the loan amount may be debt service
constrained and the maximum LTV not obtainable.
For example, if the maximum LTV is 80% and the DSCR is less than
the lender's required minimum coverage requirements at 80% LTV, the loan amount will be
reduced until the minimum DSCR is obtained. In commercial
underwriting this is referred to as loan dollars being debt service
constrained, not leverage (LTV) constrained. It's not uncommon for a property
with a cap rate in the 4%-5% range to require a 35%+ downpayment
(65% LTV) in order to maintain a lender's required minimum DSCR.
Some lenders may provide
commercial real
estate loans based
on a global DSCR. A
global DSCR is a
ratio that combines
both personal and
property income and
expenses when
calculating the
DSCR. This allows
for a property with
weak cash flow, or a
property in a low
CAP area, to still
qualify for a
commercial loan
at greater leverage provided the
borrower has
additional income to
supplement the
property's NOI.
One of the most
frequent reasons a
commercial loan or
apartment loan is
denied is because
the property does
not meet the
commercial lender's
minimum DSCR
requirements.
Understanding how a
commercial mortgage
lender calculates
the DSCR can be
helpful to know when
applying for a
commercial real
estate loan,
conduit loan, or
apartment loan.
DSCR = NOI/Annual
Debt Service
A common
misconception made
by borrowers when
applying for a
commercial mortgage
loan is that the
bank or commercial
lender only uses the
expenses from the
property when
calculating the NOI.
Commercial
lenders use a
combination of actual expenses, market expenses and reserves for
replacements, vacancy, and off-site management (if there is no
off-site management expense). Appraiser's will do the same when
reconstructing their net income analysis on the subject property.
This is an important concept to understand if you are calculating
your own cash flow analysis for a prospective commercial mortgage,
whether it's a purchase or refinance. If the property is operating
more efficiently than comparable properties (due to self management,
not keeping up with R&M, etc.), or not including a minimum vacancy
percentage, both the underwriter and appraiser will use a vacancy
factor and bring expenses inline with market - which reduces the NOI
thereby lowering the DSCR and loan amount.
Learn how to
calculate the debt service coverage ratio (DSCR)
|
